When to open probate when house is almost upside down?

I often have clients or potential clients who come to me to discuss when to open probate when their parents, or other loved one’s, house is almost upside down.  That is, what’s enough equity to make it worthwhile to file for probate?  Upside down, or when the mortgage balance is higher than the value of the home, was quite common back from 2009-2013 or so.

There were a few cases where we took the upside down probates as there is a procedure where you can get some money out of them for yourself but that’s not the focus of this post. I have other blog posts about PC 10361 and a probate forced short sale. Today we are talking about really looking at the numbers and when is it worth it to start probate.

I recently spoke to a potential client whose dad died with a house worth “between $200,000 and $300,000” in their opinion. That’s a pretty wide spread but let’s go with it for discussion purposes. I then asked how much the mortgage balance was and they said it was $175,000 and it was a reverse mortgage.

I mention the type of mortgage only because I have found reverse mortgage companies to be less flexible than traditional first mortgages. As I told this potential client the first thing to do is report the death to the reverse mortgage company and ask for a delay in them taking any action. They will have a form to fill out and that will put off an immediate filing of a foreclosure. However, this post is not about reverse mortgages so let me get back on track.

As I explained to the potential client at $200k of value it’s probably not worth filing for probate and at $300k it’s definitely worthwhile. Of course the house is worth somewhere between the two extremes. As I explained to this potential client the real estate market is currently RED HOT in most parts of California but, in my personal opinion, with all the political uncertainty and a global pandemic, it’s tenuous. I thus told them once they deal with mom’s burial and personal needs they should talk to a trusted Realtor and try to get an accurate estimate of value. I said filing for probate right away was key if there was enough value to make it worthwhile.

I ballparked $220k as the value that I suspected it would be worth it but there is wiggle room and it’s not an exact science. The problem is the home value is the biggest variable but if the Realtor runs comps and gives you an accurate estimate and the real estate market stays hot then everything should work out.

As stated I ballparked $220k but let’s see what that looks like in the real world.

First thing I did was estimated 7% for real estate closing costs that is Realtor + title company so that’s about $16k.

The other real estate item is there are always some costs of sale. Just keeping the electricity on, costs of insurance, costs of the property taxes, fixing things found by an inspection, etc…..  Let’s say $4k.

Next I estimated the total of probate attorney fees at just over $7k and the probate court costs at just under $2k so a total of $9k.

Let’s remember the mortgage is not stopping it’s increase as it’s a reverse mortgage so interest is accruing daily! It thus will be more than $175k by the time we are in a position to close escrow on a house sale in 2-3 months.  I don’t know the exact number but let’s say $178k.

So we are now at:

  • House sale price (estimate) $220,000
  • Costs of sale (estimate) $4,000
  • Minus Real Estate costs (7%) $16,000
  • Minus Probate attorney and court costs $9,000
  • That puts us at about $191,000.

If the mortgage balance is $178,000 my potential client has about $13,000 left so it’s a win!

Anything less than $220,000 in value estimate would make me very nervous and any estimate of value above $250,000 and I wouldn’t lose a moment’s sleep.

What else is there to think about?

A final 1040 needs to be filed with the IRS and likely a 1041 fiduciary return. Let’s say that costs $1,000 to file very basic returns as is the case here. We are now down to $12,000.

That really should be it. I think the family could walk away with about $12,000 if things work out as described above. That’s a pretty thin margin but it’s enough to work with in my opinion.

What about credit cards and other general creditors you ask!?  In this case I was told there were none but let’s say there were some.  Well, general creditors get paid AFTER “costs of administration.”  These costs of administration include attorney fees, court costs, tax preparation, tax payment (if any) AND the administrator’s fee. So in this case my guy would be entitled to a bit over $7k if he served as administrator of the estate. That is taxable income to him but he can share with his siblings or keep for himself depending on how big of a hassle the probate was for him.  Also, many creditors do not file claims and/or do not file lawsuits if their claims are rejected. Much like a bankruptcy those creditors then go away. So there is a real possibility that simple credit card debt would be a non-issue.

What are the biggest keys here:

  1. Get an accurate value on the house. Zillow is a good estimator but it’s just that. You need to give mom’s house an honest and objective look. Is it nicer than the average house in the neighborhood or is it in really bad shape?
  2. If the answer to #1 looks positive then file probate ASAP!  Find an efficient California probate attorney and get your case filed!

Best wishes.

-John Palley

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